Introduction to precious metals

1. Gold and silver have had a 5,000-year history as money, holding their value and standing the test of time‑independently valued by cultures across the world, without ever meeting each other to discuss it. As “hard assets”, they hold no counterparty risk and unlike money in the bank, they are nobody else’s liability. They are scarce in nature (therefore, have “intrinsic value”), with governments being unable to print them.

2. Some investors like precious metals because they are a “safe haven” asset. They are generally uncorrelated to share markets, with gold being called the “fear metal”. In the 5 worst years on the ASX, shares declined an average of 23.2% each year, with gold rising an average of 29% each year. This inverse correlation allows share market investors to diversify their portfolios with precious metals exposure, reducing overall portfolio risk in doing so.

3. Others like precious metals because they are a “hedge” against inflation, meaning that during periods of high inflation, precious metals generally perform very well. During the last period of double-digit inflation in the USA, the 1970s, gold went from $35 USD per ounce in 1971 to $850 USD per ounce in 1980, a 24x increase in a decade during which the share market moved sideways. Silver outperformed gold during this same time, going from $1.30 USD per ounce in 1971 to just under $50 per ounce in 1980, a 38x increase.

Current Debt Crisis

4. At present, the world is experiencing the largest debt bubble it has ever seen. According to the US Washington DC based Institute for International Finance, global debt currently stands at $US 299 trillion, or 338% of global GDP.

5. For the last 20+ years, western central banks and governments have used macroeconomic policies (such as fiscal, monetary, and banking prudential policies) to continue to prop up and expand the current debt bubble and prevent any deflationary recession or depression. An example of which would be the Quantitative Easing policies used during the Global Financial Crisis of 2008.

6. This was on explicit display in March of 2020 when governments and central banks around the world globally coordinated economic policy with the onset of the COVID-19 pandemic. This policy response was highly inflationary.

7. While 2022 and early 2023 has seen global economic policy makers aggressively tighten monetary policy, raising interest rates at the fastest rate in history, signs have begun to emerge that suggest that policy makers are likely to pullback or pivot from the macroeconomic policy course, to prevent a global financial crisis and an associated economic depression/crisis.

8. For this reason, professional economist John Adams believes that Australia and the global economy will continue to suffer from stagflation in the coming years, which will be highly conducive to higher precious metals prices.

Gold

9. Gold has a fascinating history spanning across cultures, with humans having treasured and fought over it for thousands of years. Throughout history gold has had various uses, with the use we will focus on being its use as a monetary metal as a form of currency. Gold is the world’s oldest international currency and is the foundation of the modern financial system, as Exeter’s pyramid shows:

10. Gold also paved the way for the modern banking system. Originally goldsmiths, who held gold on behalf of the people for safe keeping, would provide the owner of the gold with a paper receipt, this was proof of the amount of gold vested on the goldsmith’s watch.

These goldsmiths realised that their clients would not all come in for their gold at once, so were able to create “reserves”, which were in turn loaned out to other people, thus inventing the modern banking system of deposits and fractional reserve lending.

11. Gold helps reduce the impact of sharp drops elsewhere in a portfolio. Academic literature says that the optimal allocation of precious metals in a portfolio should be between 10% - 20%. Gold has nearly always done very well in periods of crisis due to people moving their capital towards it, in what is called a “rush to safety”.

12. Gold prices move inversely to other asset classes, as shown in the table below:

13. As gold is mined and becomes scarcer (as all the “easy gold” has already been mined), production yields decrease and the cost of production increases. This increase in costs of production provides upwards pressure on the gold price. if the gold price does not keep up with this increasing cost of mining, then miners will stop mining it (as it would no longer be profitable for them) and supply will grind to a halt.

Silver

14. Silver has been recognised as a monetary metal throughout history, however in today’s world is considered by some to simply be an industrial metal. Silver is extremely conductive and resistant to corrosion making it one of the most industrially useful metals in the world, with silver having more patents issued with its use than all other metals combined. Unlike gold, most industrially used silver ends up in landfills after use and is permanently lost as a result it is not cost effective to recycle it at current prices.

15. Global demand for silver rose by 18% in 2022 to a record high of 1.24 billion ounces, creating a huge supply deficit. The Silver Institute, in their 2023 report, have predicting more shortages in the years to come.

16. Silver is considered by many to be gold’s crazy cousin. It is referred to as the “Devil’s metal” in financial circles due to its extreme volatility, moving upwards and downwards in correlation with gold, however to a much larger degree. This is due to the lower market liquidity and demand fluctuations between industrial and store-of-value (monetary) uses. At times, silver trades like an industrial metal- at others, it trades in tandem with gold as a monetary metal.

The Gold-to-Silver Ratio

17. The gold-to-silver ratio (GSR) is the number of ounces of silver that it would take to buy an ounce of gold- this is the oldest continuously tracked exchange rate in history. In Roman times, the ratio was set at 12 (or 12.5) to 1. In 1792, the gold/silver price ratio was fixed by law in the United States of America at 15:1 by the US Congress.

18. The GSR ratio is a very popular tool to compare the performance between gold and silver, with some market participants making their purchasing decision as to which metal to buy based on the ratio at the time of purchase.

19. When the GSR is moving higher, gold prices are stronger than silver prices, whereas when the ratio is moving down, silver is outperforming gold. Typically, the GSR falls during precious metals bull markets (as silver typically outperforms gold during these bull markets) and increases during precious metal bear markets (as gold falls in price less than silver does, outperforming it).

20. The current extraction rate of gold to silver is only 1:9, and whilst most gold is retained through recycling, silver’s industrial use sees much of it “disappear”. This gives many silver investors the belief that the gold/silver ratio will fall substantially sometime soon, in which case holding silver would net a greater return to the investor than holding gold.

Fiat Currencies vs Precious Metals

21. Since US President Richard Nixon took the US off the gold standard on the 15th of August 1971, the world’s reserve currency has been a fiat currency, meaning it is unbacked by gold or silver.

22. Governments have debased their currencies across the world for more than 50 years under the current fiat currency system- the Quantitative Easing policies enacted after the 2008 Global Financial Crisis (as well as the recent COVID-19 crisis) are testament to this- whenever the system looks in danger of collapse, governments have “printed” their way out of it. This has led many precious metals investors to say that buying gold and silver come with a “central bank guarantee”- the guarantee that they will never stop printing money.

23. Currency and Money have many similarities, with one key difference- that money holds its value over time, whereas currencies do not. This is the key benefit of gold- that as money, it holds its value over time. The value of a dollar is constantly falling due to inflation, however an ounce of gold will always be an ounce of gold, as an ounce of silver will always be an ounce of silver. For this reason, some like to call precious metals “honest money”, as someone must do an honest day’s work for it, rather than be able to simply print it out of thin air.

24. There is a quote from former French President Charles de Gaulle:

CBDCs and Cash Transaction Ban

25. Around the world different governments and central banks are trialling Central Bank Digital Currency (CBDC) programs, including our very own Reserve Bank of Australia. A CBDC in the Australian context would be a new digital form of currency issued by the Reserve Bank, which in their own words would be “like a digital version of banknotes that is essentially universally accessible”. CBDCs would allow for an increased level of control over the currency supply for the Reserve Bank, worrying some investors as to the extent of control that central banks may have over their individual finances.

26. Governments around the world have also been trying to pass cash transaction ban legislation, however, in 2019-2020 Australian economist John Adams fought the Morrison Government’s $10k cash transaction ban here in Australia, a bill proposing to make any transactions in cash over $10,000 in value illegal and punishable by jail.

This piece of political resistance speaks to the essence of Adams Bullion, that we are Australia’s most politically active bullion dealer, actively fighting for the financial freedoms of our fellow Australians and customers.

27. Given this backdrop of cash transaction bans, the drive towards the cashless society and CBDCs, one might ask themselves the question of how to best protect themselves from such risk. Keeping funds outside of the financial system seems a great way to escape the potential tyranny of CBDCs, yet one cannot do so in cash, leaving bullion as the answer.